With reams of research, a team of chefs, and technology that rivals Wal-Mart's, the legendary retailer is reinventing the concept of convenience.

By Elizabeth Esfahani

January 1, 2005

(Business 2.0) – There's something familiar about the place, with its muted orange-and-green color scheme. The aisles are wider, though, and the displays tonier. Chilling in the fridge is the house Chardonnay, not far from a glass case packed with baguettes and cream cheese croissants that come piping-hot out of the onsite oven. An aisle away is the snazzy cappuccino machine, which offers up bananas foster and pumpkin spice java. There's sushi and, of course, bouquets of fresh-cut flowers.

Yes, this decidedly upscale little shoppe is a 7-Eleven—or it will be, when 7-Eleven CEO Jim Keyes and his team of ace technologists, trendspotters, and product developers wrap up one of the most ambitious makeovers in business history. The convenience king, most commonly known for lowbrow if popular features such as the Big Gulp and around-the-clock access to Twinkies, is moving up the food chain in search of flusher customers and fatter margins. After all, the majority of convenience-store sales come from gasoline and cigarettes—two increasingly stagnant categories. So Keyes is banking on a new, inventive inventory mix that competes more with Starbucks than with Shell. In the process Keyes and his team are pumping new life into an icon that not long ago seemed in danger of financial oblivion—and providing an object lesson in how technology and merchandising savvy can amp up a fading business's metabolism.

The transformation is way more than skin-deep. Behind surface changes like the wines—which will roll out in April thanks to a partnership with California wine giant Mondavi—are some of the most sophisticated systems for gauging demand, predicting sales, and filling orders in business today. The company has spent more than $500 million on technology in the past decade, and it has imported processes that its licensee in Japan used to make stores there unlikely avatars of cool. Among the payoffs: Managers at 7-Eleven's 5,300 stores across the United States can order up, say, a single apple turnover, and it will arrive freshly baked by morning. Each humble pastry is backed by a fanatical devotion to research and development that features a team of in-house chefs and data crunchers who can determine the best weather for pastry sales. "Technology has allowed us to take back our destiny," Keyes says.

There have been plenty of obstacles along the way. Back in 1990, reeling from disastrous acquisitions and an ill-advised leveraged buyout, the company collapsed into bankruptcy. But Keyes, a veteran 7-Eleven executive of 19 years who became CEO in 2000, has helped the chain grind slowly, steadily back: In 2004, 7-Eleven rang up estimated revenue of $12.2 billion, up 12 percent from the prior year. It has had 32 consecutive quarters of revenue growth. Profits for 2004 came in at an estimated $106.4 million, held down by lingering debt the company is working off from its bankruptcy and its heavy tech investments—but still a 66 percent jump over 2003. Its stock price recently hit a post-bankruptcy high of $23.95 after diving to a low of $6.55 in 2003. And all of a sudden, some smart money is sensing that the formerly dowdy convenience chain is on the verge of a breakout. "They have some of the best technology in the business," says Adam Sindler, an analyst at Morgan Keegan. "Wal-Mart is the most powerful retailer, but now 7-Eleven is the most innovative merchandiser in the country."

As it happens, 7-Eleven has an underappreciated history of innovation dating back almost 80 years. In 1927 it invented the concept of convenience stores, when an employee at Southland Ice in Dallas started selling milk, eggs, and other sundries to customers dropping by to replenish their iceboxes. Recognizing that refrigerators would soon kill Southland's ice business, president Joe C. Thompson moved to capitalize on demand for convenience by opening a chain of stores that would stay open from 7 a.m to 11 p.m. The concept was an instant hit. By 1980, 7-Eleven had more than 6,000 outlets and had pioneered other ideas that are now commonplace, like 24-hour service and coffee to go.

But the firm faltered in the 1980s, beset by competition from oil companies that began turning their gas stations into mini convenience stores and by acquisitions like its purchase of gasoline refiner Citgo (of which one of the only lasting benefits was to bring Keyes, a Citgo manager, into the 7-Eleven fold). Then came the ruinous leveraged buyout, which saddled the company with $4.1 billion in high-cost debt just after the market crash of October 1987. Meanwhile, the company's supply chain was a mess; stores might receive more than 80 deliveries a week, with everything from milk to magazines arriving separately and often during prime shopping hours.

At the same time, an odd thing was happening halfway around the world: In Japan, 7-Eleven had become the pinnacle of cool. There, licensee Ito-Yokado—Japan's second-largest retailer—had reinvented 7-Eleven's business model, centralizing distribution and cramming stores with fresh food. Ito-Yokado had also created an intricate information network, which let managers tailor inventory to the tastes of their customers. As a result, 7-Elevens had become hip hangouts—shoppers stopped by as often as five times a day—and sales were rising roughly 10 percent a year.

Among those most impressed by the Japanese success was Keyes, one of the managers sent from the company's Dallas headquarters to study the licensee's operations. After Ito-Yokado bought a 70 percent stake in 7-Eleven for $430 million as part of the reorganization that brought the chain out of bankruptcy, Keyes, then an up-and-comer in the finance department, was named to chair an eight-person committee charged with charting a new strategic course for the chain. Keyes had no trouble seeing the company's overarching problem. "We were a victim of our past success," he says.

That was reflected in the committee's fractious deliberations. Several members had spent their entire careers at 7-Eleven and were reluctant to shed the old ways. Moreover, there was antipathy between veterans and relative newcomers like Keyes. Keyes argued for a crash technology program that would give store managers more control over what went on their shelves—essentially, the Japanese model. Some of the old-timers pushed back, worried about the high cost of a massive technological overhaul. The old guard, Keyes recalls, saw the chain's customers as "blue-collar, truck-driving men" and harbored little hope that the company could appeal to a broader demographic. Keyes and his camp thought 7-Eleven was doomed unless it drew in more businesspeople, urbanites, and especially women.

Keyes bombarded the old guard with case studies depicting the benefits of more technology and empowerment of store-level employees. He hit them with countless demographic analyses of the customer base. After months of often-heated exchanges, Keyes won the day—and, many say, paved the way for his ascent to CEO. In the mid-'90s, 7-Eleven began pouring money into technology and upending the approach it had used for decades to run its stores and target new customers.

"I'm a very stubborn and tenacious guy," says Keyes, now 49 years old. "And I had to be tenacious to internally transform the strategy and mind-set."

Ten years on, the results have been profound. Start with the tech transformation: Today, behind their unassuming glass doors, stores throughout the 7-Eleven empire have been turned into logistical marvels. In a matter of seconds, any store manager can tap into 7-Eleven's proprietary computer system and pull up real-time data on what products are selling best at that location or across the country. Instant weather reports, too, can dictate whether more umbrellas are needed for an impending storm or if a store should stock up on a muffin that sells particularly well when the temperature drops below 40 degrees. Employees are trained to stay current on upcoming sporting events or school functions to prepare for a surge in beer runs or notebook purchases. The constant tweaking means that slow-moving items are cleared away, so managers can make room for some of the 50 or so new ones 7-Eleven introduces every week. That leads to fewer overstocks and understocks, which begets happier customers. "There's no replenishment model in the world that can respond like the eyes and ears of a retailer," Keyes says.

But even the most informed manager would flounder without the strong tech backbone. 7-Eleven stores (about 60 percent of them franchises) are equipped with NEC handhelds designed exclusively for the chain. Meanwhile, engineers from NEC—just one of two dozen tech companies working in-house at 7-Eleven—are toiling on a second-generation version of the device, which will incorporate a touchscreen and wireless radio-frequency technology.

Using the handhelds, store operators place orders each morning for items that need replenishing the next day, and many of those requests are beamed to one of the 23 third-party distribution centers 7-Eleven has partnered with in the past decade. (The data also goes to HQ to be stored and analyzed.) At the centers, in warehouses akin to enormous refrigerators, local suppliers drop off their inventory for sorting. Every distribution center, too, is surrounded by a bakery and a commissary that churns out sandwiches, salads, and other fresh items. Each afternoon the orders are divvied up by store and route, and by 5 a.m. the next day, every doughnut and Slurpee cup has reached its destination. Consider that most of the 500 million items radiating annually from the warehouses are perishables, and the feat becomes even more impressive.

The system is a godsend for entrepreneurially minded store managers like Andrey Vinogradsky. At 8:30 on a recent morning, Vinogradsky prowls the aisles of his San Francisco store with the NEC handheld, scanning best-sellers like the King's Hawaiian Sweet Roll. The device instantly calculates how many have moved since last week and suggests an order, but Vinogradsky decides to up the number to 17, knowing that tomorrow is Thursday, his busiest day. As he works his way through the store, he passes several items that are there only because of his own initiative. Six months ago, for example, when Vinogradsky arrived at the outlet, he immediately noticed a flood of tourists who came in asking for maps, postcards, and other items that the store didn't carry; now it does, because Vinogradsky lined up a local vendor and began stocking them. He added snack foods from Mexico-based Bimbo for the Latino contingency. He even makes sure there's always a pot of macadamia-nut coffee for one special customer who comes in three times a day for a cup. "All of these tools allow me to provide what my customers really want," Vinogradsky says. "Without them, my job would be twice as hard."

The technological overhaul has done more than empower store managers. It has helped 7-Eleven regain control over distribution and product decisions that for decades had been dictated by its major suppliers. Traditionally, powerhouses like Anheuser-Busch and Coca-Cola have exerted enormous influence over which products a convenience store could carry, how much of them it got and when, and even how they were displayed.

Now 7-Eleven is getting suppliers to play by its rules, in part because the precise sales data it generates helps the suppliers predict demand for their products nationwide. "They'd been doing it the old way for a hundred years," Keyes says. Anheuser, for one, resisted giving up control. But, Keyes says, it eventually saw "the economic advantage" in ceding stocking and distribution decisions to 7-Eleven. Today store managers can communicate directly with Anheuser's delivery staff—face-to-face, by phone, and increasingly by handheld computer alone—to customize their mix of beverages. For the past four years, Keyes has seen a 6 to 10 percent annual increase in sales of Anheuser beer at 7-Eleven—a startling jump in an industry where 2 percent growth is considered healthy.

David Podeschi, 7-Eleven's senior vice president for merchandising, sits in a cavernous office lined with just some of the 2,000 products the retailer releases every year. It's his job to figure out new ways to mine the torrents of data that store managers and their machines are sending back to headquarters. Podeschi can see, for example, that cinnamon coffee does well in Southern California, while shoppers in the Northwest tend toward hazelnut. By combing through that kind of sales data, as well as monitoring outside stats and pop-culture trends, he and his team uncover clues about what their customers will clamor for next. "We've gone from having no idea what we were selling to predicting what customers want even before they know it," Podeschi says.

Now, when 7-Eleven spots a trend, it goes out and creates a product to match. Often that means partnering with small third-party manufacturers to create the perfect exclusive offering. In late 2003, for example, 7-Eleven noticed that supermarket sales of cleaning wipes were exploding. Bathroom and kitchen wipes didn't really fit 7-Eleven's convenience format, since those sorts of purchases could wait until the next grocery-store trip. Then, from one of the retailer's weekly brainstorming sessions, the perfect product emerged: a towelette specifically designed to remove coffee stains. At a chain where 10,000 pots of coffee are brewed each hour, it was a natural fit. The company chose a manufacturer to develop the wipes, and under 7-Eleven's guidance, it came up with a low-cost, sleekly packaged product that was small enough to fit in a glove compartment or desk drawer. Seven months later 7-Eleven Coffee Wipes landed in stores nationwide.

Called "team merchandising," that approach was also responsible for one of the quiet hits of the season: roadkill-shaped gummy candy, made for the chain by food giant Kraft. "We saw from sales data how popular Kraft's Trolli gummies were with kids," Podeschi says. "And we know that kids like things that are over-the-top gross. We literally handed Kraft this idea: 'Why don't you do Trollis that look like roadkill—squashed squirrels and snakes?'" Kraft's development team loved the idea, and by August, Trolli Road Kill candies were hanging on 7-Eleven racks.

The roadkill gummy set is an important demographic for 7-Eleven, but it's not the dream slice of the consumer universe on which the company has essentially staked its future. Keyes has already proven that he can make inroads with groups that 7-Eleven once thought were a lost cause—women, for instance. In the mid-1990s, Keyes championed a plan to put an early version of the credit card reader at 7-Eleven gas pumps. The notion was opposed by several high-ranking managers, who argued that the readers would just confuse many consumers and that, if they were deployed, they should be put inside the store rather than out at the pump. "Their logic was that you needed to drag people in for the impulse purchase," Keyes recalls. "But I said, 'We're in the convenience business, and I'm making it more convenient to buy gas.'"

The naysayers weren't convinced, and Keyes was forced to test the idea with a limited pilot project. It was a smash: Not only did sales of gas increase, but sales inside the store went up as well, as gas purchasers often popped in to pick up other items. More important for Keyes's long-range goal of broadening the customer base, the card-ready pumps brought in a surge of women customers. Why? It turned out that moms with kids loved being able to pay without having to leave the car—and the kids. Keyes was eventually cleared to put readers on all 7-Eleven pumps, making the chain one of the first convenience retailers to get them.

The hunt for new customers has since become dramatically more ambitious. Today, in an industrial kitchen at 7-Eleven headquarters, a staff headed by four culinary chefs is inventing the high-margin fresh-food offerings that will be key to making 7-Eleven a daily destination. One recent launch was a line of sandwiches on artisan breads aimed at attracting more upscale buyers, and executives stop by daily to sample everything from jalapeño and cream cheese taquitos (a big seller last fall) to turkey wraps, which will roll out nationwide this year. "At this job, you quickly learn to spit," jokes fresh-food director Alan Beach, who estimates he tries as many as 15 concoctions every day. Now fresh food is 7-Eleven's hottest growth area: Though only 8 percent of total sales, the category grew 15 percent in 2004 and is expected to beat that this year.

Keyes and 7-Eleven are clearly on a roll, but obstacles still loom. The company reduced its debt by 15 percent last year, but it still faces $1.5 billion left over from the leveraged buyout. (7-Eleven went public again in 1991, though Ito-Yokado and 7-Eleven Japan now own a 77 percent share.) 7-Eleven is the biggest U.S. convenience store chain not owned by an oil giant (Shell is No. 1), and it licenses its brand name to thousands of international outlets as well. But the industry is badly splintered, giving 7-Eleven only 4 percent of the estimated $317 billion U.S. market. Other convenience chains—2,300-store Circle K, 1,366-store Casey's General Store, 1,361-store the Pantry—are trying to bring technology to their operations too, although none is remotely in 7-Eleven's league. And Keyes says his company's biggest challenge now is making sure that store managers understand how to use the data at their fingertips: "You can supply all the technology in the world, and it won't matter if they don't think like entrepreneurs." Furthermore, he says his biggest rivals aren't other convenience chains but the likes of Starbucks and McDonald's. Taking them on is a tall order, but analysts think Keyes's initiatives have 7-Eleven on track for a record run of profits. According to Michael Coleman, an analyst with Southwest Securities, 7-Eleven's earnings are poised to grow at least 15 percent annually for the next five years.

Keyes has already begun to roll out smaller, classier stores in places the chain never ventured before: downtown business districts, airports, and universities. Several of the remodeled shops are in Austin, 7-Eleven's test market, where stores act as guinea pigs for the new merchandising concepts and food offerings that Keyes believes will really turbocharge growth.

In one Austin store on a recent afternoon, the aisles brim with fresh produce and salads, and the air is sweet with the scent of freshly baked cookies. A smartly dressed lawyer named Steven Hake stops in for a quick bite. Though he has worked nearby for 17 years, he never considered a 7-Eleven meal anything more than a last resort. But about a year ago, he stopped in to buy a drink and sampled a focaccia sandwich. He's been hooked on 7-Eleven's $3.49 lunches ever since. "When I eat out, this is hands-down my favorite place," Hake says. "If 7-Eleven is making these changes to attract customers like me, they're succeeding."

SALES MIX

Faced with stagnating gasoline sales, 7-Eleven has made its merchandise more diverse than its rivals'.

INVENTORY TURN

Higher merchandising efficiency has led to better "turn"—the number of times stores cycle through their inventory annually.